AK Steel on a Roll

AK Steel's (NYSE: AKS) earnings report yesterday was enough to turn a bear into a bull -- almost. In a striking reversal of last year's losses, AK Steel posted a per-share profit of $0.85 for its second quarter of 2004.

Granted, $0.66 of those profits came from one-time gains, but AK's management correctly ascribed the balance of those profits to the hard work (and labor concessions) of AK's workers. Congratulations are in order for AK management and its workers for their fine quarter, but the company is not out of the woods yet.

In a reprise of information given in its pre-announcement of two weeks ago, AK again ascribed its return to profitability to strong demand for steel generally, to the rising price of steel on the spot market (which co-steelmaker Schnitzer Steel (Nasdaq: SCHN) has also noted), and to AK's continued use of surcharges to offset the prices AK itself pays for raw materials. In fact, there was precious little "news" contained in yesterday's announcement.

What news there was is contained in the company's cash flow statement. And let me pause here to say thank you to AK for not withholding this essential piece of information, despite the news it contains. Precious few companies are as forthcoming about bad news.

According to the cash flow statement, over the past six months, AK has recorded negative cash from operations -- $96 million worth. On top of that, the company has spent $28 million on capital expenditures. Add those two numbers up to calculate AK's free cash flow, and you will quickly see that the company's GAAP earnings profitability is only a mirage. As far as real cash earnings (what we call "free cash flow") go, AK remains deeply in the red, bleeding away a quarter-billion dollars per year, at its current free cash flow run rate. Meanwhile, the company's balance sheet continues to deteriorate, with long-term debt rising another $60 million since Dec. 31, 2003.

Achieving GAAP profitability is only the first step, Fools. If AK is to become a worthy investment for your hard-earned dollars, keep an eye on the free cash flow to ensure the profits are real. And keep an eye on the debt to know whether the company can survive the inevitable steel industry downturn.

Steel DynamicsIn a related story, readers with good short-term memory may recall that last week, I postulated that Steel Dynamics' (Nasdaq: STLD) institution of a dividend probably meant that the company became free cash flow positive last quarter. Guess what -- it did. For the second quarter of 2004, Steel Dynamics earned $12.6 million in free cash flow. Fool on!

Fool contributorRich Smithhas no interest in any of the companies mentioned in this article.

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